Call VS Put

An option contract is simply an option to buy or sell an underlying asset. There are options on a plethora of assets, such as commodities, indices, futures contracts, stocks, and interest rates. Although there are various types of options, we will be sticking with stock options, or equity options.

Quite simply, an equity option contract is a decision about whether you want to buy or sell a stock at a specified price, on or before a specific date; it’s not different from any other options we have in life.

There’s one thing you need to know when trading options. If you buy an options contract, your maximum loss is limited to the amount of premium paid. On the other hand, when you sell short, or “write”, an options contract, you would receive an initial credit. However, when you write call options, your risk is theoretically unlimited. If you write put options, the losses can be substantial. This is one of the reasons why we focus on buying options, and not writing them without hedging our position.

Call Options vs Put Options

Now, let’s look at the difference between call options and put options.

A call option gives you the right to buy an underlying stock at a specified strike price, on or before an expiration date. Conversely, a put option gives you the right to sell an underlying stock at a pre-determined strike price on or before the specified expiration date. When you buy 1 call option or 1 put option, you pay a premium to receive the right to buy or sell 100 shares of an underlying stock, respectively, and you’re not “obligated” to do so.

That said, the amount of premium you paid is the maximum amount you could lose. However, if you hold an options contract and it expires “in the money” you would be automatically exercised on that option. Therefore, you need to make sure you have enough capital in your account to buy or sell shares of the underlying if you plan on holding options until the expiration date. Generally, we will exit our positions before the expiration because we don’t want to take the risk of buying or selling the stock when we’ve already taken large profits or small losses on the options trades.

Don’t fret if you don’t understand these terms yet. We’ll go over the “moneyness” of options and the terms: in the money (ITM), at the money (ATM) and out of the money (OTM) when we go over “Options Pricing.”

In order to receive the right, but not the obligation, to buy or sell the underlying stock at a specified price any time on or before the expiration date, the owner pays the seller, or writer, the option premium. If you buy a call option, and the underlying stock increase significantly, the owner of the call option would have unrealized profits. On the other hand, the writer of the call option would suffer.

Now, the writer of an options contract takes the opposite side of risk and receives a premium. However, the writer of an options contract is obligated to deliver shares of the security if they are exercised, or if the options contract expires in the money.

Again if you write options, you would receive a premium for taking on the risk. If you sell short, or write, a call option, you are obligated to sell shares of the underlying stock if the call option holder exercises the option, or if the option expires in the money. If you write a put option, you are obligated to purchase shares of the underlying stock, if the put option expires in the money or the holder exercises the option.

Keep in mind that naked writing options, or selling without hedging the options, is extremely risky. You shouldn’t look to write options when you’re first starting out. Moreover, you’re going to need some collateral if you’re looking to write options to collect premiums.

Conclusion

Entering into a call or put option is an entire game of speculation. If one has trust in the movement of the price of the underlying asset and is ready to invest some money with an appetite to bear the risk of premium amount, the gains can be substantially large. In terms of the Indian options market, a contract expires on the last Thursday of the month before which the contract should be executed else contract can be allowed to expire worthless with the premium amount foregone.

Thus, it completely depends on the risk appetite of the investor and the faith in the direction of the price movement of the underlying asset for which the option contract is undertaken. Call and put options are two exactly opposite terms and a combination of speculation and financial ability will help in extracting maximum financial gains